Some protection in bad markets
To be sure, Singer and Mann found that dollar-cost averaging provided some protection in poor markets. When they focused on the 12-month periods between 1926 and 2008 that fell into the bottom 20 percent of performance, they found that dollar-cost averaging provided an average of 11.6 percent more wealth than investing all at once.However, in typical and strong markets, dollar-cost averaging left investors with 2.9 percent and 13.4 percent, respectively, less wealth than investing using a lump sum approach. That means the protection dollar-cost averaging offers in poor markets comes at a price.
Instead of trying to time the market, it makes more sense to focus on asset allocation, says Robert Dubil, associate professor and lecturer in finance at the University of Utah in Salt Lake City. "Diversifying your assets is more important than diversifying over time." So, when investing a lump sum, you first would decide the allocations between different investment types. Then, you would get into the market at one time, and maintain your allocation parameters by rebalancing on a regular basis.
If, despite the research, you're still nervous about diving into the market in one swoop, you're best off scheduling your investments over a period no longer than about six months, Singer and Mann found. You'll gain about 7 percent in protection against market drops, while giving up just 1 percent in return. Drag out the process to more than about 18 months, and you'll gain little additional benefit, but will see your return drop by about 6 percent in typical markets.
This isn't to say that dollar-cost averaging has no role in saving and investing plans. It does. However, for most people it is more of a budgeting tool than an investment strategy, says Robert Atra, CFA and chair of the finance department at Lewis University, Romeoville, Ill. Most investors squirrel away smaller sums on a regular basis rather than a large sum all at once, because that's how their money comes in.
If you're fortunate enough to have a lump sum to invest but jumping into the market all at once will keep you up at night, dollar-cost averaging over a short period of time can offer some protection at a relatively modest cost. What is less effective is to "become a market timer and have cash pile up because you think some times are better than others," Sachs says.
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